Hazy outlook for aviation

STREET CUES

Managing yields in domestic markets will be a challenge for the sector.

Of late, aviation stocks have rallied following a drop in aviation turbine fuel (ATF) prices. But some analysts aren't reading too much into it.

A top foreign brokerage house in its recent research report mentioned that the aviation sector was deeply in the red with players estimating that FY07 net losses to be over $500 million.

Stung by the sharp losses, the first signs of rational behaviour in the industry are visible. Domestic airline companies have announced a "traffic congestion surcharge" to neutralise the impact of longer waiting and flying times in key domestic airports on account of inadequate infrastructure.

"The load factors are still lower than a year back as capacity addition has outstripped passenger growth. The airline stocks have rallied in recent weeks as oil prices have declined. We maintain our negative stance on the sector," stated the report.

Enam Securities sees the sector as "Underperformer". Despite an evident turnaround, the brokerage house perceives the balance sheet of Jet Airways to be vulnerable to competition.

Jet reported revenues of Rs 1,930 crore (up 31 per cent), EBITDA of Rs 14 0 crore (down 42 per cent) and net profit of Rs 40crore (down 34 per cent) in Q3FY07. EBITDAR margin at 17 per cent showed a sharp improvement on a sequential basis owing to higher passenger traffic, better domestic yield and a stable overall cost environment.

In international business, Jet broke even with Rs 15 million EBITDA. The turnaround was driven by 17 per cent y-o-y yield improvement from business class passengers. With 160 per cent increase in international capacity, analysts expect over 50 per cent revenue contribution to come from international operations by March 2009.

"EBITDAR margin at 17 per cent in Q3FY07 is a stark improvement over 6 per cent in Q2FY07. While the management expects margins to stabilise at 20-24 per cent in a steady state, we believe it will take another 3-4 quarters before the industry capacity induction and pricing environment .Considering the turnaround in international operations, we have revised upwards the overall EBITDAR margin to 18 per cent for FY08E. However, aggressive international fleet expansion along with the introduction of new US routes are expected to keep net margins well below their peak level in FY05. Managing yields in domestic markets continue to remain challenging," said Hemant B Patel, lead analyst, Enam Securities.

Spicejet is ICICI Securities' pick of the sector as they perceive it to be best positioned to benefit from the aviation J-curve on the back of high operational efficiency and sustained high load factor. As they believe the worst is over for the low cost carriers (LCC) and it is set to script a turnaround by FY09E.

"We would like to rate Spicejet with "BUY" as it provides a play on the true LCC model. After correcting from a high of Rs 84/share in May'06,the stock presents a buying opportunity at the current market price. Globally, LCCs command premium valuation over FSCs as evidenced by higher EV/EBITDAR and market cap/sales multiples.LCCs trade at an average 2.8x market capitalisation/sales (actual). LCCs premium valuations are justified because of the sustainability of the business model and greater reach among the masses," said ICICI Securities in its report.